It’s been another risk-off session in global markets, with equity markets and bond yields lower, as investors remain concerned about a prolonged US-China trade war. The 10 year Treasury yield hit its lowest level since September 2017, the 10 year Australian government bond fell below the RBA’s cash rate and NZ rates made record lows across the curve as markets anticipated more central bank easing. The USD has strengthened against the risk-off backdrop and is approaching its highs of the year. The NZ Budget is today.
Market sentiment remains fragile and dominated by US-China trade war concerns. The current focus among market participants is whether China is going to announce restrictions on exports of its rare earth deposits, which are used in a range of consumer goods, electronics and military equipment. Yesterday, the Chinese state-run People's Daily issued an editorial entitled “United States, don't underestimate China's ability to strike back”, in which it said “don't say we didn't warn you" in reference to China’s willingness to use rare earths as retaliation in the conflict. US direct imports of rare earths from China were reasonably small last year, at around $180m, but they are found in many imported consumer goods.
On a more positive note, the US Treasury declined to name China as a currency manipulator in its semi-annual report to Congress, which would have further inflamed the already tense relations between the two countries.
Global equity markets have fallen amidst these continued concerns about the trade war, with the S&P500 1% lower on the day, having been down 1.3% at one stage. The S&P500 is now almost 6% below its all-time high reached at the end of April and is sitting just above its 200-day moving average. European equity indices had earlier fall 1.2% to 1.7%.
Global rates have continued to push lower, in sympathy with the falls in equities, as market conviction on central bank easing increased. The 10 year Treasury yield reached its lowest level since September 2017, at 2.21%, during New York morning trading. This left it more than 100bps below the highs reached less than seven months ago. US yields have retraced somewhat over the past few hours after a very weak 7 year Treasury note auction, which tailed almost 2bps, suggesting that the big decline in rates may be starting to impact investor demand. The 10 year Treasury yield is currently 3bps lower on the day at 2.24%, while the 3m10y yield curve is 11bps inverted, which continues to fuel market chatter about the risks of a US recession.
Market expectations of Fed rate cuts have continued to build, albeit without any economic data or central bank talk to trigger the moves. The market is now pricing an almost 80% chance of a September rate cut, with 40bps priced by the end of this year and over three cuts by the end of 2021. The rates market looks reasonably well-priced for a series of “insurance cuts” by the Fed in response to the trade conflict, but rates will fall further if the US economy were to slip into recession (not our expectation), triggering a deeper easing cycle from the Fed.
Rates markets elsewhere have gone the same way as the US, with a 5bp fall in Australian and NZ government bonds yesterday and a 2bp fall in German bunds overnight to -0.18%. The Australian 10 year government bond reached 1.48%, inverting to the RBA cash rate. In NZ, the 10 year swap reached 1.935%, with the market now pricing a better than even chance that the OCR falls to 1% by early next year. Yesterday’s NZ ANZ Business survey was disappointing, with only a small bounce in both the own activity and headline business confidence readings, despite the government’s decision not to go ahead with its proposed capital gains tax. Our economics team noted that, at face value, the level of own activity is consistent with annual average GDP growth of around 1.5%, below both our and the RBNZ’s forecasts, while the plunge in residential construction intentions, to the lowest level in a decade, implied big downside risks to the residential investment outlook.
The risk-off backdrop has led to further gains in the USD, with the DXY approaching its highs of the year (reached late April) and the BBDXY index (which has a ~20% weight to EM currencies) reaching a fresh high for the year. The increase in Fed rate cut expectations has been outweighed by USD demand stemming from the increase in risk aversion it seems.
The Japanese yen and Swiss franc have predictably outperformed against the pick-up in risk aversion – both currencies are close to unchanged against the USD on the day. The EUR is down 0.2% to 1.1135. As had been widely foreshadowed, the European Commission formally issued a letter to Italy’s finance minister informing the government that it hadn’t “made sufficient progress towards compliance with the debt criterion” and asking for an explanation. This is the first stage of a process that could ultimately end up with Italy entering excessive deficit proceedings, if the government does not make sufficient changes to its Budget, and receiving a fine from the EC. The NZD is the weakest currency in the G10, and has fallen 0.5% to 0.6510. Last week’s low in the NZD of 0.6482 is now back firmly in sight.
In central bank news, the Bank of Canada kept rates on hold at 1.75% as universally expected by analysts and the market. The Bank said current policy settings were “appropriate” and that recent data reinforced its view that slow-down in growth late last year and early 2019 was temporary. That said, the Bank highlighted that "trade restrictions introduced by China are having direct effects on Canadian exports" and broader trade tensions were “heightening uncertainty.” The CAD initially fell after the statement, but has since recovered, while shorter-dated Canadian bonds are a few basis points lower on the day. The market prices a 75% chance of a rate cut over the next year by the BoC.
There was no change to loan-to-value (LVR) restrictions announced at the RBNZ’s Financial Stability Report yesterday. A large chunk of the FSR press conference was devoted to the RBNZ’s proposed changes to bank capital requirements, with Governor Orr reiterating that the Bank was approaching the consultation process with an open-mind. Orr added that “if we see sufficient reason to be changing any of the parameters we will and we will make it clear why we did”, but he emphasised that ultimately the Bank wants banks to hold more capital.
The NZ Budget is released this afternoon.
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